The look-back periods, the defences, the orders the tribunal may make and what creditors and counterparties should do.
When a company enters insolvency, its creditors are paid from what remains. If, in the period before the process began, the company transferred assets to a favoured creditor, sold them at a low price, or arranged its affairs to keep assets away from creditors, the Insolvency and Bankruptcy Code, 2016 allows those transactions to be challenged and reversed. For creditors of a company in the process, these provisions can enlarge the estate. For a recipient of a transfer, they are a risk. This note describes the main categories. It is general information, not advice on a particular transaction.
Who may apply
The resolution professional (or the liquidator, in liquidation) applies to the Adjudicating Authority. Under Section 25(2)(j) the professional is bound to file applications for avoidance of transactions in accordance with Chapter III of Part II. Where the professional fails to do so, a creditor may apply in respect of certain transactions, for example under Section 47 for undervalued transactions.
Preferential transactions: Section 43
A transaction is preferential if the company, to or for the benefit of a creditor, surety or guarantor, transferred property or an interest in it on account of an antecedent financial or operational debt, and the transfer puts that person in a position better than they would have been in under the liquidation waterfall. The look-back period is two years before the insolvency commencement date where the beneficiary is a related party, and one year otherwise. A transfer made in the ordinary course of the company's business or financial affairs is not preferential, and nor is the creation of a security interest in new property to secure new value given, as the section provides.
Undervalued transactions: Sections 45 to 48
A transaction is undervalued if the company made a gift, or transferred assets for a consideration whose value is significantly less than the value of the consideration the company provided. The same look-back periods apply, two years for related parties and one year for others. The transaction is protected if it was made in the ordinary course of business and in good faith, with reasonable grounds for believing it would benefit the company.
Transactions defrauding creditors: Section 49
Where an undervalued transaction was deliberately entered into to keep assets beyond the reach of a person entitled to make a claim, or to adversely affect that person's interests, the tribunal may set it aside. Section 49 does not depend on the same time limit as the preceding sections, though the dates will matter to the evidence.
Extortionate credit: Section 50
Credit given to the company on terms that required grossly exorbitant payments, or that grossly contravened the principles of fair dealing, within the two years before the insolvency commencement date, may be reopened, and the tribunal can set aside the debt or vary its terms.
Fraudulent and wrongful trading: Section 66
Section 66 deals with the conduct of business. Persons knowingly party to carrying on the business with intent to defraud creditors may be ordered to contribute to the company's assets. Directors who knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency, and who did not exercise due diligence to minimise the loss to creditors, may also be made liable to contribute.
What the tribunal may order
The orders include requiring the property to be vested in the company, requiring a person to pay a sum representing the benefit received, releasing or discharging security, and requiring the parties to be restored to their previous position, with protection for a person who acquired the property in good faith and for value. The sums recovered join the estate and are distributed to creditors under the plan or the waterfall.
For creditors and counterparties
- A creditor who received payment or security shortly before the company's insolvency should be ready to show that it was in the ordinary course of business.
- A creditor in the process can ask the professional what avoidance applications are being considered, and can press for them when a suspicious transaction is apparent.
- Records matter. Documents contemporaneous with the transaction carry far more weight than later explanations.
This note is general information on the law at the date of publication. It is not legal advice, and it should not be relied on without advice on the facts of a particular matter.
